Drax poised for a surge in earnings

IT SOUNDS so simple. You take coal - huge quantities of the stuff, up to 36,000 tonnes a day - and shovel it into a power station. At the other end, out comes electricity, which you then sell at a healthy profit. What could be a more reliable way of making money?

Alas, life isn't quite that simple, as Drax Group found to its cost four years ago. Electricity prices collapsed. Its main customer, TXU Europe, was brought to its knees, and Drax, owner of the largest coal-fired power station in Europe, found itself in a fairly similar position.

Drax, whose sole asset is its power station in Selby, North Yorkshire, supplying about seven per cent of the UK's electricity needs, ended up in the hands of bondholders. But, as if you didn't know, the price of electricity picked up. Drax was refinanced. And since last December, the company's shares have been trading on the stock market.

They closed on Friday at 889p valuing the group, which joined the FTSE 100 last month, at £3.6bn.

This is a hard company to value, and despite the apparent simplicity-of its business, it is high risk. It is exposed to any sharp rise in the price of coal.

It is exposed to any fall in the price of the electricity it produces - a price that tends to follow the price of gas, the main rival to coal as a fossil fuel for power generation. And it is exposed to changes in the price of permits to produce carbon dioxide - coal, after all, is essentially the C of CO2.

Probably the most significant of these unknowns is the price of electricity. Certainly, the company can and does try to buy itself some security by agreeing a price now for power that will be supplied in one, two or three years' time. By the end of last month, contracts had been agreed for almost two-thirds of the electricity Drax will produce next year.

Nevertheless, it is just conceivable that there will be a collapse in the price of gas and therefore in the price of electricity. This is the big risk for Drax's profitability-But imagine that does not happen. Assume electricity remains expensive. Then, Drax will churn out enormous amounts of cash.

The company's policy is to pay out a relatively paltry regular dividend. But on top of that, it has pledged to hand back 'excess' cash flow - the money it has left over after setting aside sufficient for working capital and investment - to its shareholders. This will be in the form of special dividends.

In October, Drax will pay the first of these dividends, between 75p and 80p a share. There is likely to be a further chunky sum in the spring of next year. Exactly how much will depend on the extent to which the company refinances itself, thus creating extra elbow-room for payouts.

No one can assume that such largesse will continue indefinitely - 2006 has been peculiar in that Drax is only now beginning to pay tax. But even so, the potential returns over the coming four or five years are huge.

• Midas verdict: If you are prepared to bet that energy costs will stay high, Drax offers enormous potential. The company is being careful not promise big dividends unless it can comfortably afford them. But we reckon that the chances of fat returns are good. Buy.

MIDAS UPDATE: Lock in gains at Misys now

THE sparring for control of software group Misysis now under way and has lifted the shares to 2421/4p, up from the 213¾p at which we tipped them six weeks ago.

Could an out-and-out bid battle drive the price much higher? Yes. Can we be confident that all the bids won't fade away? No. We are happy to pocket the 13% profit.

Another share that has done well since we tipped it is property group Shaftesbury. Its assets, largely shops and restaurants, are concentrated in London's West End - Covent Garden, Chinatown and around Carnaby Street.

When we highlighted the company on June 4, we said Shaftesbury was a classy operation with high-quality assets whose share price had suffered an unwarranted mauling in May's stock market sell-off.

And indeed, the shares have bounced back. You could have bought Shaftesbury at 510p if you followed our advice. They are now 565p.

Following the rise, Shaftesbury shares no longer offer compelling value. And as we said in June, investing in a company such as this exposes you to the property market in a very small geographic area - one that is dependent on retail spending and tourist traffic. Take profits.